Already suffering from the dot-com bust, venture capital investing is
being further challenged in light of the recent terrorist attacks and
growing signs of recession.
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SAN FRANCISCO, Sept. 25 Venture capital investing, the high-risk
financing of early-stage companies that has been markedly curtailed in
the last year, is being further challenged in light of the recent
terrorist attacks and growing signs of recession, those investors say.

The venture capitalists assert that the slowing of the economy, coupled
with an uncertainty about the public markets, is affecting all facets
of their industry, including their ability to raise new funds, their
decisions about which and how many companies to invest in, and their
expectations about when their existing investments will become
profitable.

Putting a fine point on the concern, the
National Venture Capital Association issued a statement today saying the
industry "is preparing for an extremely difficult economic environment"
in the next 12 to 18 months.

At the heart of the issue
is a question about how venture capitalists can expect to sell the
investments they make. Typically they take their companies public, or
sell them outright. But those so-called "exit strategies" are sharply
limited, said Mark Heesen, president of the National Venture Capital
Association, a trade group based in Arlington, Va., with 400 member
firms.

"We were already in tough times," Mr. Heesen said.
"What Sept. 11 did was make the likelihood of the I.P.O. market opening
in the next four quarters pretty unlikely. A lot of V.C.'s are saying
it might not open until 2003," using the abbreviation for venture
capitalists.

The investors say that as a result, they
must put more money into companies in which they are already invested,
making sure to keep them afloat until an exit strategy emerges. The
numbers on investments made in new companies bear that out: this year,
venture capitalists will invest about $50 billion in start-up companies,
Mr. Heesen said, compared with $105 billion last year.

Still, venture capitalists point out that this market appears to be so
difficult because this year is being compared with the two years
previous, which were anomalies, with exorbitant returns being driven by
the dot-com boom, and the expansion of the public markets.

Steve Lisson, editor and publisher of InsiderVC.com, said recent events
were reminiscent of the time around the gulf war, when the industry had
its last downturn. At that time, the ability to attract capital to
invest in start-ups "fell off dramatically," but he said the industry
bounced back within several years to have the "best period in its
history."

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Stephen Lisson is not a conventionally likable guy. On more
than one occasion, he's implied that I'm the single stupidest
reporter he's ever talked to. He has kept me on the phone for
hours at a time listening to the most arcane statistics, until I've
slammed down the phone in frustration. He calls people who
disagree with him "lickspittles." He dismisses many of the
visitors to his Website as "parasites."

And yet over the past few months I have repeatedly gone back to
Lisson and his new Website, InsiderVC.com, because Lisson has
the best data out there about venture capital, and often the most
interesting things to say about it.

Venture capitalists are the rock stars du jour of the financial
world, a species of money managers who are believed capable of
superhuman wisdom. Business magazines tend to assume that
the richer you are, the smarter you must be, and the Internet
boom has lavished untold riches on the venture capitalists who
invested early.

"Untold" is a key word here, because hardly anyone knows
exactly how great these riches are. In this way, venture-capital
funds are very different from, say, mutual funds. Venture
capitalists talk vaguely about "triple-digit returns," but even
successful funds tend to keep their returns a closely guarded
secret. And even when they do reveal numbers, they can be hard
to understand.

This is where Austin, Texas, entrepreneur and venture-capital
gadfly Stephen Lisson comes in. Through years of research and,
apparently, a lot of cooperation from a network of sources
willing to send him copies of the reports that venture-capital
firms send out to their investors, Lisson has gathered an
immense database of information about venture-capital firms'
investments and profits.

Lisson doesn't make all his data public--much of his information

is limited to subscribers, and he can be picky even about whom
he allows to subscribe. But what he's already revealed in the
public sections (for example, see: Database Example) of
InsiderVC.com is fascinating. Some of his data shows exactly
what you might expect. Benchmark Capital Partners' 1995 fund-the
fund that famously invested in eBay--has already returned to
its investors 38 times the money they put in. Investors who put
money into the fund that Kleiner Perkins Caufield & Byers,
Silicon Valley's best-known venture-capital firm, raised in 1996,
have already made a similarly spectacular return of over 1,000%.

But you'll also find that the 1997 fund raised by Hummer
Winblad, another venture-capital firm that has traditionally
received a lot of attention from the press, has so far returned
only 42% of its investors' money. That might be a decent
showing in any other era, but in the middle of the biggest
technology boom or bubble in history, it's not great, and not
nearly as good as some of Hummer Winblad's peers. (Typically,
venture funds distribute cash or stocks as the companies in their
portfolio are sold or go public. In theory, that means they can
continue paying out money to investors for a very long time, but
in practice, almost all of their profits are made in the first six
years of the fund.)

Even more interesting are the data that Lisson has gathered on
how venture capitalists value their investments. Venture
capitalists measure their own performance by an "internal rate of
return"--an annualized rate of increase in the value of their
investments. Often that'll be a number in the high double digits,
sometimes in the triple digits. Sounds pretty good when you
compare it with the typical mutual fund. But if you look at the
InsiderVC.com database, you'll find that funds claiming
immense annual returns sometimes pay out a lot less money to
investors than you'd imagine.

As of March 2000, Benchmark claimed an annualized return of
an amazing 279% for Benchmark III, the fund that the firm
raised in 1998. But wait a second! Lisson's data also show that
Benchmark III hadn't actually distributed any cash or stock to its
investors. That 279% return was based on a guesstimate of the
value of the companies Benchmark has invested in--companies
that, since they hadn't gone public, are notoriously hard to value.
One of those companies, Living.com, has already gone bankrupt,
reducing the value of Benchmark's investment from an estimated
$74 million to zero. And it's hard to believe that, with the Net
bubble bursting, Benchmark's investment in eBags.com is really
worth the $20 million-plus that Benchmark valued it at in
March.

For individual investors who don't have a prayer of putting their

money into funds that deal only with tech insiders, large
institutions, and foundations, analyzing exactly how much the
top funds make can certainly seem like an academic exercise. It
can all sound arcane, confusing, and dull, and if you are not an
investor in venture-capital funds, I don't recommend it as a
hobby or a business. But it's important that somebody do it.
First, because venture investment is the engine driving much of
Silicon Valley's technological innovation. And, second, because
it's important for somebody like Lisson to remind investors and
the business press that venture capitalists are not the gods of
finance they are often made out to be, but instead, very well-
trained money managers. Sometimes very smart money
managers, sometimes very lucky money managers, but
nonetheless, financiers who'll often make a lot of money and
sometimes, like the rest of us, flub it.